MORTGAGED LIVES: A special report.; Profiting From Fine Print With Wall Street's Help

By DIANA B. HENRIQUES with LOWELL BERGMAN

Published: March 15, 2000

Bernae Gunderson, a certified paralegal who lives in St. Paul, is not intimidated by fine print. But she was still puzzled by the mortgage documents she got in May 1998 from the First Alliance Corporation. This did not sound like the affordable home equity loan that she and her husband had been promised.

So about 2:30 p.m. on May 26, Mrs. Gunderson called the manager of the mortgage company's local office and asked all the right questions about rates, monthly payments and fees. And she got reassuring answers that confirmed her understanding of the terms of her loan.

But those comforting answers were mostly lies, as revealed in a tape-recording Mrs. Gunderson made of her conversation to play later for her husband, Scott. In fact, $13,000 in fees was added to the loan, and its interest rate was designed to rise a full percentage point every six months. Facing mortgage payments already $150 a month higher than when they first closed on the loan, Mr. and Mrs. Gunderson have been forced to work as much as 10 extra hours a week to meet their payments.

''We have three children, and an extra $150 a month really can help out for clothing and everything else,'' Mr. Gunderson said in a recent interview. ''It does make a lot of difference.''

Mrs. Gunderson added, ''The stress is unbearable.''

The Gundersons are among scores of consumers who have complained to state regulators about First Alliance, a national home-equity lender based in Irvine, Calif. More than a dozen homeowners have already sued. They all assert that the company has used a deceptive sales pitch, delivered by loan officers recruited from big auto dealerships, to lure homeowners into high-cost loans that expose them to the threat of foreclosure and financial ruin.

The company, which steadfastly denies wrongdoing, has also been sued by the AARP and by regulators in five states. One, Washington State, is seeking to suspend it from doing any business there. A California appeals court concluded last year that the company ''trained its employees to use various methods, including deception, to sell its services.'' The federal Justice Department is investigating First Alliance, and the company has withdrawn from an industry trade association because of negative publicity.

But First Alliance still has some very important supporters: the investment banks on Wall Street that help it raise the money lent to people like the Gundersons. Those banks began raising significant amounts of money for the company in the early 1990's, after it had already come under investigation in California for discriminatory lending. An investigation by The New York Times and the ABC News program ''20/20'' shows they have pumped hundreds of millions of dollars more into First Alliance in recent years, even as civil lawsuits and state investigations have raised increasingly troubling questions about First Alliance's business practices.

The money raised by Wall Street for First Alliance and dozens of similar companies has financed a quiet revolution in the financial habits of millions of Americans whose low incomes or blemished credit histories otherwise prevented them from obtaining conventional loans. Such subprime borrowers, as they are called in the lending industry, have turned in increasing numbers to finance companies that cover the risk of default by charging them significantly higher fees and interest rates.

Since 1989, Wall Street investment banks have sold more than $316.2 billion in bonds for subprime lenders -- more than twice the dollar amount of the high-yield, or junk, bonds that companies used to finance takeovers in the 1980's. First Alliance has been a big beneficiary of these new mortgage bonds, receiving nearly $2 billion the last decade, including $103 million raised through Lehman Brothers just three months ago.

William J. Ahearn, a spokesman for Lehman, said the firm's role in selling bonds backed by subprime loans, known in the financial world as underwriting, includes a careful review to make sure investors have the facts they need. He said that Lehman officials were fully aware of First Alliance's legal problems and believed that the company had stepped up its efforts the last 18 months to prevent abuses. Lehman, he said, is an ''underwriter, not a regulator.''

For much of the last decade, the federal government has largely left regulation of the industry to the states, despite a series of Congressional hearings that revealed rampant abuses. The first round of hearings, in 1994, established that many companies were taking advantage of unsophisticated homeowners -- many of them minorities; the second round, in 1998, suggested that the problems were spreading nationwide.

The testimony did not dissuade Wall Street investment banks from vastly expanding their stake in the industry. They have financed lending operations, helped companies sell shares to the public and, in some cases, formed partnerships with the companies.

Consumer advocates contend that First Alliance, whose actions have been extensively documented in court cases and regulatory actions, is typical of an industry that often preys on low- and middle-income people desperate to escape financial difficulties. Industry officials say, however, that subprime lenders can provide a valuable service to consumers whose credit records otherwise disqualify them for conventional loans.